AT&T's profits were up slightly in the third quarter, thanks in large part to the popularity of the Apple iPhone 3G.

The nation's largest phone company announced on Wednesday a 5.5 percent boost in profits for the third quarter. Net income for the company increased to $3.2 billion on sales of $31.2 billion, which were up about 4 percent, compared to the same quarter a year ago.

Wireless, which accounts for about 40 percent of AT&T's total revenue, once again saved the day for AT&T, proving that it continues to be a cash cow, even as the economy slumps. Profits for wireless services surged 21 percent on revenue that was up 15 percent on the quarter.

The big driver for wireless during the quarter was Apple's latest iPhone, which went on sale in July. AT&T is the only cell phone operator in the United States to offer the iPhone. And the exclusive deal to sell the hot phone is paying off for the company. AT&T reported that it activated 2.4 million iPhones during the third quarter, with about 40 percent of those going to new subscribers.

It should come as little surprise that the iPhone 3G would help boost profits for AT&T. The phone company's decision to sell the phone for a subsidized price of $199 has likely helped boost sales. The previous version of the phone was not subsidized, initially costing AT&T customers $499. The higher-end version cost $599.

AT&T is making up for any losses from the phone subsidy by forcing customers to sign a two-year service contract on a service that costs much more than the average AT&T cell phone service. The strategy seems to be working. Despite the hefty service fee, consumers are still flocking to the iPhone.

In total, AT&T added 2 million net wireless subscribers, which is an increase of 2.7 percent.

And in general, customers seem satisfied with their service. AT&T's churn rate, or the rate at which its customers ditch its service for another service, improved to 1.2 percent from 1.3 percent.

Despite strength in its wireless business, AT&T is still facing major challenges on the wireline side. In the past, the conventional wisdom was that phone companies were immune to economic downturns. The idea was that people always need a home phone.

But that thinking is changing, as consumers have more choices for communication than ever before. Cable operators also offer voice services as part of competitively priced service bundles. And then there are people who simply cut the cord and use their cell phones.

Roughly 17 percent of households in the United States, or more than 20 million customers, are getting rid of their old wireline phones and using their cell phones instead, according to market researcher Nielsen Media. The trend will likely continue, as one in five U.S. households is expected to be wireless-only by the end of 2008, according to Nielsen.

This helps explain why AT&T lost 990,000 primary phone lines during the quarter, which helped drag total revenue for AT&T's wireline business down 2.2 percent, to $17.6 billion.

Clearly, wireless revenue, which now accounts for 40 percent of AT&T's total revenue, is helping keep the company in good standing. But AT&T has also been trying to augment its wireline losses with investment in other land-based services, such as broadband. The company has committed to spending $7 billion on extending its fiber network to build its new U-verse service. U-verse allows AT&T to sell a triple play bundle of services that includes telephony, broadband and television to compete against the cable companies.

Overall broadband sales were up for AT&T, but it wasn't enough to offset the losses of the traditional landline services. Even though AT&T's U-Verse product has gotten high marks from consumers, it is still available only to a small portion of AT&T's customer base. Rollout of the service has been slow. And this will likely hurt the company over the long run. But deploying more fiber, and getting the services up and running, is no easy task.

With the holiday buying season approaching, AT&T is no doubt hoping that iPhone sales will remain strong. But given the state of the economy, experts are predicting slow sales for all consumer electronics. This week, the Consumer Electronics Association said it expects holiday electronics sales to grow only by about 3.5 percent in 2008, much lower than in previous years.

About the author

Marguerite Reardon has been a CNET News reporter since 2004, covering cell phone services, broadband, citywide Wi-Fi, the Net neutrality debate, as well as the ongoing consolidation of the phone companies. E-mail Maggie.
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